What are some of the pitfalls in purchase price allocations?
Having gone through a few of these, sometimes differences arise between expectations or estimates prior to the transaction and fair value measurements performed after the transaction. An example is contingent consideration arrangements – estimates from the deal team’s back-of-the-envelope calculations could vary from the fair value of the corresponding liability measured and reported for GAAP purposes. To the extent amortization estimates are prepared prior to the transaction, any variance in the allocation of total transaction value to amortizable intangible assets and non-amortized, indefinite lived assets – be they identifiable intangible assets or goodwill – could also lead to different future EPS estimates. While most of the time our clients approach these allocation exercises with an open mind, sometimes bridging these differences – surprises, really – can take a bit of time and effort.
Do companies ever prepare preliminary allocations, such as before a deal is even closed?
There is no universal practice we have observed. Some clients come to us with no priors, so to speak. Others will have prepared some figures – maybe placeholder-type numbers, or maybe something with a bit more underlying analysis – for tax planning or other purposes. The level of detail can also vary and may or may not include specific splits among the various types of identifiable intangible assets. Going back to the theme of sources of surprises, however, the allocation itself is only one aspect of transaction due diligence. Whether or not allocations are prepared in advance, buyers will have engaged in some form of financial modeling prior to the close of transactions.
What are the benefits of looking at the allocation process early?
The opportunity to think through and talk about some of the unusual elements of the more involved transactions can be enormously helpful. We view the dialogue we have with clients during the process as a particularly important part of the project. So, obviously, a process that starts early allows all involved more space to examine transaction items together, loop in not just FP&A and corporate development personnel but also folks from the technical teams as necessary, ask questions, and evaluate potential solutions and/or approaches. We would hope this deliberative process results in a more robust – well-reasoned and well-supported – analysis that is easier for the external auditors to review, and stands the test of time requiring fewer true-ups or other adjustments in the future. Surprises are difficult to eliminate, but as they say, forewarned is forearmed. A head-start is a luxury we are not always going to have, but we certainly like it when we get lucky on that front.
What other problems/issues do you help clients navigate as part of the process?
As part of our full suite of services, we handle a number of different kinds of special projects that corporate finance departments may be looking to outsource, completely or partially. For example, our firm helps clients think through certain financial or strategic questions – what level of cash flow reinvestment will best balance competing shareholder interests? Or, what is the appropriate hurdle rate when evaluating projects for capital budgeting exercises? In other instances, we perform financial due diligence and quality of earnings analyses for some transactions.
When it comes to purchase price allocations, however, most of the time clients contact us well after the transaction has progressed or closed. Over time, discussions with some of our clients have shifted a bit from providing fair value measurements exclusively on the back-end of transactions to getting a bit of preview as companies think through the transactions. To revisit an earlier question, we would like to think that our purchase price allocations are better – more robust, fewer surprises – when we have also worked with the clients before the close of the transactions on elements like some financial due diligence or contingent consideration estimates, or even broader corporate finance studies.